What the Arctic drilling freeze means for the US energy industry

A decision by the Obama administration Friday to postpone new offshore oil-and-gas exploration in U.S. Arctic waters deals a setback to energy companies hoping to stake a claim in a hydrocarbon-rich region thought to contain some 27 billion barrels of oil and 132 trillion cubic feet of natural gas. But the move will likely also spur the energy industry to push for opportunities elsewhere under a new presidential administration, including controversial areas like the Arctic National Wildlife Refuge in Alaska and parts of the eastern Gulf of Mexico and Atlantic, currently off limits to oil exploration.

The mining prohibition would only obstruct claims for two years. Likewise, the Obama administration's decision not to issue new Arctic-drilling permits would likely only keep offshore exploration in those waters on ice until 2018 or 2019, the soonest the Trump administration could likely pull together its own five-year plan to supplant the current one.

"This is still well within the realm of modification" by the incoming Trump administration, said Kevin Book, managing director of ClearView Energy Partners. "But there is a significant drag on whatever Trump does want to do by having to undo what Obama finalized. This is about playing to stall rather than to win."

If, as expected, the Trump administration does begin writing a new Interior Department's five-year plan spanning 2019 to 2024, not only could those same Arctic regions become available for lease as soon as 2019 or 2020, but currently off-limits areas in the eastern Gulf of Mexico could see exploration when a law prohibiting their development expires in 2022.

Icy challenges

In the wake of Royal Dutch Shell's $7 billion entry into and hasty retreat from the U.S. Arctic last year, it's unclear exactly how many companies may have bid for Arctic leases for 2020 and 2022, the proposed leases now abandoned in the latest Interior Department five-year energy development plan. But even with oil prices low (a barrel of West Texas Crude is currently trading at less than $50 per barrel) and exploration budgets tightening, oil and gas companies looking toward the future remain very interested in the Arctic, where the U.S. Geological Survey estimates roughly 40 percent of the world's untapped reserves lay.

"People see that there will be the need for new exploration," said Dr. Charles Ebinger, a senior fellow in the Energy Security and Climate Initiative at The Brookings Institution. "I think if a Trump administration comes in and tries to reverse Obama's decision, two or three years into this administration we'll see some new interest in exploring in the Arctic and other deep areas offshore."

Shell's $7 billion failure underscores just how difficult exploration and drilling can be under icy, Arctic conditions in the waters north of Alaska. Yet many companies still consider it less risky than operating in other oil rich regions of the world, where political instability can threaten a company's long-term investments. "You can find oil and gas and then have it nationalized overnight," Ebinger said. "[Companies] think they can deal with the technical risk better than they can deal with the political risk."

Exploration options

One place energy companies will naturally turn is the Gulf of Mexico, Book says, where companies face a stable regime (the U.S.), existing infrastructure, a well-understood regulatory scheme, and fairly stable returns. Though many of the more attractive tracts there are already leased, that could change within the next four years as a moratorium on leasing parts of the eastern Gulf of Mexico expires.

The Gulf of Mexico Energy Security Act (GOMESA), passed in 2006, prohibits the leasing of certain areas of the so-called "Eastern Planning Area" around Florida as well as portions of the largely-leased "Central Planning Area" until 2022. If it chooses, the Trump administration could begin the process of leasing those areas for offshore oil and gas development in its own five-year plan, Book says. "The Trump administration will have at its disposal not only resources available under existing law, but could potentially slot in resources that will become available upon the sunset date in GOMESA," he said.

Energy companies could also push a Trump administration perceived to be more energy-friendly toward new domestic onshore options as well, pulling the controversial debate over drilling in the Arctic National Wildlife Refuge (ANWR) back into focus, Ebinger noted. "I think you may see the energy companies — supported probably by the Trump administration — look much more favorably toward onshore leases," he said "You may see the industry push to get those areas open, and I think you may also see the industry push to revisit some of the offshore leasing in the Atlantic and offshore Florida."

A Russia play

For those energy companies looking specifically for a toehold in the Arctic, another option may soon become available.

"One area that's perhaps under-appreciated in the wake of Trump's victory is the possibility of offshoring Arctic development in Russia," Book said. "There are clearly some companies for whom a rapprochement with Russia creates opportunities to get into the Russian Arctic, and that would be a much more attractive choice given the development that they've already got."

Russia, its own economy reeling from low energy prices, could prove receptive to investment by foreign energy companies, a prospect much improved by U.S. President-elect Trump's commitment to improve relations between the two countries. Energy companies would also benefit from the substantial infrastructure Russia has in place in its coastal regions—infrastructure the northern shore of Alaska largely lacks.

Therein lies another ancillary consequence of delaying the leasing of U.S. Arctic waters. As former Commandant of the U.S. Coast Guard Robert J. Papp explained to CNBC last year, the U.S. has not committed the same resources and infrastructure to its swath of Arctic territory that Russia and other nations have to their own waters, even as warming global temperatures open up more of the region to maritime traffic and commercial activity each year. For instance, the distance between where Shell was operating last year and the nearest safe harbor at Dutch Harbor, Alaska was between 800 and 900 nautical miles. In the case of bad weather or an emergency, crews operating in the U.S. Arctic had nowhere to go.

This lack of infrastructure and capability was demonstrated in 2012 when a the crew of a drilling rig (also belonging to Royal Dutch Shell) got caught in high seas had to evacuate the rig. Coast Guard helicopters lifted the crew to safety, but with no means to secure it the rig was left adrift. Eventually it struck a barrier island, but its onboard tanks—holding 150,000 gallons of diesel fuel and 10,000 more gallons of hazardous chemicals—did not rupture. If they had, neither the Coast Guard nor Shell would have had the capability on hand to manage the ensuing environmental disaster.

The next administration will have to evaluate the double-edged proposition that drilling in the Arctic represents. On the one hand, oil and gas exploration and exploitation brings its own environmental and safety risks. On the other, creating a commercial imperative in the Arctic will give rise to other commercial imperatives, including the development of infrastructure and support facilities needed to safely manage the region.

"If you believe with climate change there's gong to be more sea traffic of all kinds — not just oil and gas but all kinds — coming down through the Bering Sea and the Bering Strait, it's vitally important that we have a maritime capability to deal with whatever kind of potential disasters could occur," Ebinger said.. "And right now we don't have anything."